Down Arrows
A market sell-off adds to the challenges facing Washington's fiscal policymakers.

Wednesday, January 23, 2008

AS INTERNATIONAL stock markets tumbled Monday, the "R" word, recession, seemed to be giving way to the "P" word: Panic set in across the world as investors feared a U.S.-led global slowdown. It's not entirely clear why this happened now. Market players have known about the troubles in the U.S. subprime mortgage market, and its attendant credit crunch, for months. Though gloomy forecasts abound, most prognosticators have said that any U.S. downturn should be mild. And continued strong growth in Europe and Asia was supposed to offset a U.S. slump. Some investors told reporters that the markets were reacting to President Bush's unveiling of a $145 billion anti-recession plan Friday. Rather than reassuring people, the announcement was taken as official confirmation that bad times are indeed ahead. Then it was sell, sell, sell.

U.S. and European markets stabilized a bit after the Federal Reserve Board slashed interest rates before the opening bell yesterday, though the Dow Jones industrial average still fell 1 percent. Fed Chairman Ben S. Bernanke, facing criticism from Wall Street that he has not done enough to prop up the markets, can hardly be accused of sleeping through this crisis. Indeed, the risk is that Mr. Bernanke may seem himself to be panicking, given that the Fed stepped in just eight days before it was scheduled to hold a regular rate-setting meeting.

The sequence of events illustrates how little room policymakers have to maneuver, and how easily their well-intentioned steps can go awry. Inflation hit 4.1 percent in 2007, the highest level in 17 years. Perhaps Mr. Bernanke can ignore inflation in favor of recession-fighting for now. But at some point, the declining dollar and other factors will constrain his ability to cut interest rates. Some aspects of the current predicament are not easily treated by conventional monetary and fiscal medicine. For example, the Fed's rate cuts are supposed to spur consumer and business activity by reducing the cost of borrowing. But the credit crunch reflects lender concerns about borrowers' creditworthiness; some people can't get cash at any interest rate. Given the lax lending standards that prevailed until recently in the housing market, some tightening of standards may even be healthy.

A similar point applies with regard to fiscal policy, an intrinsically blunter instrument than monetary policy. Congress and the president can give the economy a short-term boost through temporary tax relief and other measures targeted to the consumers and businesses likeliest to spend quickly. Yet even if they act by Feb. 15, as Senate Majority Leader Harry M. Reid (D-Nev.) suggested yesterday, the first checks would not go out until May or June, according to the director of the nonpartisan Congressional Budget Office. And that assumes that Congress and the president avoid the temptation to lard a stimulus package with public works spending or tax breaks for special interests, all of which would not only waste money but create time-consuming political conflict. The financial markets have taken a roller-coaster ride, from the euphoria of the subprime boom to the angst of this week's market bust. Government, though, must steer a steadier course.